This specialist fund has given its investors a wild and profitable ride.
In 1810 Nathan Rothschild, the founder of the banking dynasty, said that investors should "buy at the sound of cannons, sell at the sound of trumpets." Rothschild was referring to the tendency of markets to react to the news of war and peace, but this holds true for the many situations where investors overvalue certainty and run away from risks.
Warren Buffett says that investors will "pay a very high price in the stock market for a cheery consensus." A canny investor can sometimes spot opportunities by looking for situations and markets where there is tremendous uncertainty and apprehension, buying where others fear to tread.
One possibility is investing in a country that many investors won't even touch with their worst enemy's bargepole, the "R" in the acronym BRIC; Russia.
Buy When Others Are Fearful
In August 1998 the Russian financial crisis reverberated through world markets, culminating in the bailout of the Long-Term Capital Management hedge fund. I viewed this as one of Rothschild's buying opportunities and started looking for potential investments.
Since buying shares in foreign markets can sometimes be difficult, particularly in a country such as Russia, I decided to look for an investment trust which specialised in Russia and came across the First Russian Frontiers Investment Trust.
Eleven years on I remain a shareholder, having sold most of my original purchase along the way, during which time the company has changed its name to The Eastern European Trust (LSE: EST) to show that it has diversified away from Russia. In 2008 its shares fell by more than 80% causing the directors to replace the founder managers Pictet & Cie with BlackRock last May. The shares have rebounded spectacularly in 2009, rising by some 74%.
The Eastern European Trust has comprehensively outperformed the FTSE over the last decade; whilst the FTSE has fallen by 17% its share price has increased by almost eight times. Even allowing for reinvested dividends that's a substantial outperformance.
Investment Trusts in Two Paragraphs
An investment trust is a company whose primary business is investing in other companies; you can find more information about investment trusts here. They represent a relatively easy way to invest overseas especially where it would be time consuming and expensive to buy and monitor individual shares. The downside is that the managers charge a fee; for The Eastern European Trust this is roughly 1.1% of the company's assets every year (with bonuses for beating the benchmark indices).
When investing in relatively illiquid and volatile markets I prefer investment trusts over unit trusts because unit trusts need to keep cash on hand and are sometimes forced to sell investments to meet client sales whereas investment trusts can simply ignore any selling. This is particularly important when dealing with markets like Russia, which are exposed to wild fluctuations resulting from political events (e.g. the invasion of Georgia in 2008).
So Why Russia?
Currently 53% of the portfolio is invested in Russia, 17% in Poland, 11% in Turkey with the rest mostly in the former Warsaw Pact countries. The investments are strongly biased towards oil and gas companies (Gazprom, LukOil), miners (Norilsk Nickel), telecommunications and finance, all of which are lowly rated in comparison to their western counterparts. The shares are currently trading at a discount of about 10% of the net asset value, which is in line with many investment trusts, and you can find the 2008 annual report on BlackRock's website here. Don't expect any dividends from these shares.
Mention Russia to people and it throws up all sorts of images, from Lenin, the battles of World War II, Dr. Zhivago and shot putters of dubious gender. Today the image many investors have of Russia is "gangster capitalism"; a country where investors are as likely to have their assets confiscated by the authorities as to be protected by them.
True; the rule of law isn't particularly strong in Russia and property rights aren't respected to the same degree as in the West. But if you look at the early history of American and British capitalism, you will see the dubious activities of robber barons and note that many businessmen made (criminal) fortunes during prohibition.
I'm bullish on Russia for the medium to long term but it will take time to unwind the effects of seven decades of authoritarian rule. Unfortunately many people, particularly policymakers in Western governments, thought that all you needed to do was sit back and watch post-Soviet Russia turn into a free market democracy overnight. Hopefully those Russians with property interests should come to see that the Rule of Law and strong property rights are the best way to defend their interests
If, and it's a big if, Russia moves towards western-style property rights and the rule of law then Russian shares should close much of the gap between their valuations and those for equivalent western companies. But you should remember that these shares can be extremely volatile and the political risks make them a suitable home for no more than a small fraction of an investor's wealth.
More from Tony Luckett:
> Tony owns shares in the Eastern European Trust.
